rosalinda.blog

I spent a lot of time writing this forum post below, thought I’d leave it here for memory.

“Thank you Prof and classmates for the insights and riveting discussion expanding on the topic of QE. With regard to Prof’s statement that managing monetary policy is both an art and a science, as well as what Prof mentioned in class on Fed watchers, I’d like to expand on why I find it so interesting how central bank communication has become increasingly critical for market participants.
For instance, we just saw how markets reacted this past Tuesday when newly inducted Powell accidentally let slip the fourth rate hike. We also saw the interesting movement in the markets when the January FOMC meeting minutes were released last Wednesday (first, when algorithms digested the “appreciable risk that inflation would continue to fall short of the Committee’s objective”, dollar and yields were instantly knocked lower, stocks rose – then when actual humans read the minutes to learn that as a whole it was decidedly hawkish, dollar and yields were jawboned higher, stocks fell).

I’d like to highlight an interesting week back towards the end of January (week of 22 January, to be specific, when Trump was at Davos), when there had been a de facto currency war of sorts. Essentially, statements from Trump, Mnuchin, Draghi and Kuroda were basically in the driver’s seat of price action in FX that week.

To zoom in on BoJ and USD/JPY in particular, there was the January MPM on Tuesday, January 23rd. Just some backdrop, the BoJ was up till recently viewed as the most dovish central bank, and any communication that departed from that would be wildly out of character and thus result in an outsized market reaction. However, early in January this year, BoJ trimmed the size of its JGB purchases by JPY10bil in the 10 year to 25 year segment, and this was viewed somewhat as “stealth tapering”. So next in focus for BoJ rhetoric was signals as to when they would join the rest of their major global peers in starting the conversation on normalisation. So then came the January monetary policy meeting, and while the BoJ had essentially doused any hope for discussion on withdrawing stimulus, there was a slight tweak in inflation language. Just some context: inflation has been the laggard for the Japanese economy, and it’s also a crucial data point for the BoJ, as Shaun has detailed in his deep explanation on BoJ’s past and present efforts. So while output gap has tightened, business confidence has been increasingly rosy, the fact that inflation still falls far short has always been emphasised on by BoJ. But because BoJ appeared more upbeat on inflation during the January meeting, this immediately sent a knee-jerk lower in USDJPY – which Kuroda later tried to talk back during the post-meeting press conference.

Another case of this would be the Fed back in the 80’s, which Mr Chew talked about in class. Then Fed Chair Volcker was a firm hawk in his quest to conquer double digit inflation – his credibility as a hawk and talking down of inflation emerged key to the success of the Fed in combating exceedingly high inflation.

As you can see in the above instances, it’s amazing how markets can dissect central bank rhetoric (some strategists would actually routinely compare word for word, central bank minutes from different months to identify key changes) and how single statements and tweaks in wording can impact the markets.

Further, I’d also like to briefly mention the possible deployment of the Fed Put against a backdrop of quantitative tightening / the balance sheet taper, which Samuel has cast light on. I read somewhere that in early February at the height of the recent turbulence of sorts in the markets (the week of the Black Monday “redux” I believe), the Fed’s balance sheet actually increased substantially – meaning short-term asset purchases were made, which may have been deployed to mitigate the extreme price action we were seeing in the stock market.

This leads me to point out a somewhat troubling aspect of QE, which is relative a lack of guidance published regarding the specific schedule. To illustrate, in October last year, which marked the start of the balance sheet runoff, it was discovered from data published by the Fed itself, that the Fed’s balance sheet had actually grown rather than shrunk (which led some financial journalists to joke that the Fed’s trading desk hadn’t gotten the memo). This is actually in stark contrast to quick action when the Fed first kickstarted QE and asset purchases. As such, this haziness somewhat surrounding the precise timeline of quantitative tightening could enable the Fed to make asset purchases in short, immediate time frames, and essentially deploy the “Fed put” in a bid to support the stock market temporarily.”